2023-07-05 12:37:00 ET
Summary
- Indian equities have re-rated in recent months, boosting the performance of the WisdomTree India Earnings Fund.
- Given the resilient macroeconomic backdrop and the prospect of a capex upswing this year, EPI’s focus on ‘old economy’ sectors like materials and energy could pay off.
- The liquidity infusion post-demonetization could catalyze an accelerated investment cycle and more valuation upside to equities.
India’s underperformance relative to Asia Pacific equities has been clawed back this year following the Q2 rally. Valuations have risen in line with the optimism, however, and the MSCI India benchmark now screens richly at ~21x fwd earnings (at the upper end of its high-teens historical average). Yet, rising 2023/2024 earnings growth forecasts and a strong macro backdrop (as evident from indicators like GDP growth, industrial production, and PMIs) mean the valuation is well-supported. And given the public sector-led capex recovery promised at this year’s Union budget isn’t yet in full swing, expect incremental growth upside from gross fixed capital formation.
The WisdomTree India Earnings Fund’s ( EPI ) materials/energy-focused portfolio is well placed to benefit from a near-term investment upswing and, given its more modest low-teens estimated P/E valuation (vs. over 20x for the more consumer-focused Indian equity benchmarks), arguably has more room to re-rate. Adding to the impetus for EPI is the latest RBI demonetization of INR2k notes, which will add deposits and liquidity into the banking system, in turn easing short-term rates and catalyzing an accelerated pace of investments.
Fund Overview – A Portfolio of Highly Profitable Indian Large-Caps
The US-listed WisdomTree India Earnings ETF seeks to track (pre-expenses) the performance of the fundamentally weighted WisdomTree India Earnings Index, comprising a basket of Indian large-cap stocks subject to profitability and liquidity constraints. The ETF maintains a 0.8% expense ratio (gross and net) and a net asset base of $933m, making it a reasonably priced single-country Indian ETF available to US investors (albeit at the upper end of the expenses charged by comparable ETFs like the iShares MSCI India ETF ( INDA ) and Franklin FTSE India ETF ( FLIN )). A summary of key facts about the ETF is listed in the graphic below:
WisdomTree
From a sector allocation perspective, the fund is fairly diversified. In contrast with its comparable funds’ focus on Financials, the largest EPI sector exposure is to Materials (23.7%), followed by Energy (17.7%) and Financials (16.1%). The other sector exposure over the 10% threshold is Information Technology at 11.5%, while Utilities (7.1%), Industrials (6.6%), and Consumer Discretionary (5.7%) are also meaningful exposures for the fund. On a cumulative basis, the top five sectors contribute ~76% of the total portfolio.
WisdomTree
The single-stock portfolio allocation is led by Indian multinational conglomerate Reliance Industries Limited ( OTC:RLNIY ) at 6.8% and steel-making company Tata Steel ( OTC:TATLY ) at 6.2%. ICICI Bank ( IBN ), tech services company Infosys ( INFY ), and Oil and energy company Oil and Natural Gas Corporation Limited round out the top five list. With the ten largest holdings contributing 36.2% of the overall portfolio, EPI remains a relatively well-diversified ETF from a single-stock perspective.
WisdomTree
Fund Performance – Strong Capital Growth; Modest Income
On a YTD basis, the ETF has returned 6.4% in market price terms, matching comparable US-listed Indian ETFs. Zooming out, the fund has compounded at an unremarkable ~3% pace since its inception in 2008, weighed down by a challenging backdrop in the initial years (note the fund launched in the midst of the ’08 financial crisis). Over the last ten years, however, the annualized total return stands at an impressive +8.2%, boosted by a total return of +24.7% over the previous three years. Where EPI disappoints is on the tracking error vs. its benchmark – even after accounting for fund expenses, the >1.5%pt annualized delta since inception is concerning.
WisdomTree
The fund’s distribution yield is above comparable Indian ETFs but generally runs below 1% (although the SEC 30-day yield is currently 1.2%) and is volatile through the cycles. While Indian equities don’t typically offer attractive income, they do offer high growth and attractive reinvestment runways. So even though the distribution is unlikely to move higher anytime soon, growth investors will find a lot to like here.
Morningstar
Demonetization Adds Timely Cushion to the Growth/Inflation Cycle
In a surprise announcement, India’s central bank, the RBI (or the ‘Reserve Bank of India’), has decided to withdraw INR2k banknotes from circulation. Unlike the last demonetization episode in 2016 (incidentally when these notes were introduced), however, these notes will remain legal tender up to September 2023. While the 2023 demonetization is unlikely to cause anywhere near the disruption of the 2016 announcement, the value of INR2k banknotes in circulation is still significant at over 10% as of Q1 2023. So even in a conservative scenario where half of the notes are withdrawn, we could see a massive INR1.5trn of liquidity return to the interbank market.
Reuters
The impact of this liquidity infusion into the domestic banking system, along with the recent variable rate repo auction by the RBI, will significantly ease liquidity in the coming months. As a result, expect downward pressure on short-term rates ahead, ultimately translating into lower deposit rates and incentivizing investments throughout the economy. In addition, a higher deposit base also cushions against any negative impact from weaker external growth spillovers, as well as any turbulence from the upcoming monsoon season. A lasting impact on economic activity is unlikely, though, given this denomination isn’t as widely used for transaction activity and the use of digital payments has increased in recent years.
A Reasonably Priced Play on the Indian Investment Upcycle
While EPI has risen alongside the other major Indian equity indices, its portfolio skew toward ‘old economy’ sectors like materials and energy means the fund’s forward P/E multiple remains far more palatable in the low teens (vs. ~21x for the MSCI India benchmark). And unlike the rest of the world’s major economies, the Indian macro backdrop has been resilient, benefiting from a combination of domestic consumption and a step up in public sector-led investments. The economic strength has translated into corporate earnings growth as well, with consensus estimates now calling for ~22% EPS growth this year. Via its holdings in conglomerates like Reliance Industries and Tata Steel, among others, EPI is particularly well-positioned to ride the capex cycle recovery. The pace of liquidity easing post-demonetization of the INR2k notes, along with the resulting downside pressure on short-term rates, presents an additional catalyst for overall investments and potentially even equity valuations.
Yardeni
For further details see:
EPI: A Reasonably Priced Play On The Indian Investment Upcycle